How the US domestic fiscal and monetary policy impact Australia and Singapore

Introduction
Throughout the first half of 2020, the Covid-19 pandemic has caused major economic disruption
and dangerous health issues to countries around the world. The rapid spread of the virus has
caused lockdowns and travel bans for countries, bringing world economies to experience a slump
in GDP growth as demand for many industries like the aviation and tourism sector decreases. As
a result, the US government policymakers have decided to implement massive stimulus packages
and expansionary monetary policy aimed to support and recover the economy back to its original
condition. The purpose of this report is to analyze the international macroeconomic impact of the
US stimulus package and expansionary monetary policy on Australia and Singapore. Through
the information gathered, both Australia and Singapore can be more informed and will be able to
make better decisions in response to the external shock caused by the expansionary fiscal and
monetary policy in the US.
Balance of payments
Balance of payments (BOP) is a statement that consists of domestic and foreign transactions in a
given period. The main focus of BOP is the current account (CA) and the financial account (FA).
CA measures a country’s net exports of goods and services and net international income receipts
while FA measures the difference between sales of assets to foreigners and purchases of foreign
owned assets. Transactions in the BOP is calculated under the double-entry accounting system
where the sum of the credit entries must balance with the sum of the debit entries. Depending on
the type of income or expenditure, CA and FA should be credited and debited accordingly.
The US
According to the latest data from the Bureau of Economic Analysis, the US has recorded an
overall CA deficit in 2020. This have been the economic trend for the US for the past 5 years. In
Q4 of 2020, the US has recorded a CA deficit of -188.5 billion US dollars. A CA deficit would
mean that the US is currently spending more on imports than they can export. This is primarily
due to the high consumer spending in the economy. Moreover, the US dollar has an overvalued
exchange rate. When a currency is overvalued, exports become relatively less competitive and
imports from other countries become more attractive. US residents would prefer to purchase
imports from countries such as China rather than buying domestic products. A CA deficit shows
that the US net foreign wealth is decreasing and will become a net borrower from the rest of the
world. Borrowing is not necessarily bad because if the borrowings are financing investment that
generates economic growth and income in the future, it will benefit the country. However,
excessive borrowings should be avoided as it may result in a loss of foreign investor confidence.
Based on the intertemporal model, the CA pattern in the US would mean that the real rate of
interest in an open economy is less than the real rate of interest in a closed economy. Consumers
are willing to forgo future consumption to obtain a marginal increase in current consumption and
the return on additional domestic investment is greater than the cost of foreign borrowing. The

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US will import current consumption goods from other countries but in the future, they would
need to repay the borrowings by sacrificing their future consumption.
Australia
Based on the data gathered from the Australian Bureau of Statistics, Australia has experienced a
change from a CA deficit in 2018 to a CA surplus in 2020. In Q4 of 2020, the country has
recorded a surplus of 14.5 billion US dollars. The reason behind this change is most likely due to
the increase in export demand and fall in imports as a result of the depreciation of the Australian
dollar relative to other countries. Unlike the US, a CA surplus would mean that Australia is
exporting more than importing. Australia’s net foreign wealth will be positive and the country
will become a net lender to other countries. Through the intertemporal model, the country can
boost future consumption through external means. Instead of consuming all resources in the
economy domestically, Australia can export the excess supply in the economy. This would result
in a balance of trade surplus and a FA deficit. In this scenario, the real rate of interest in an open
economy is predicted to be more than the real rate of interest in a closed economy. The return on
lending to other countries is greater than the rate at which consumers are willing to sacrifice
current consumption for future consumption. Also, the return on lending is greater than the
forgone domestic return on investment in physical capital. The country may be giving up current
consumption but, in the future, foreign countries will need to repay the borrowings and
Australia’s future consumption will improve.
Singapore
As stated by the Department of Statistics Singapore, Singapore is experiencing a CA surplus in
2020. During Q4 of 2020, Singapore’s current account surplus was 36.8 billion US dollars.
Singapore has been maintaining a CA surplus ever since the early 2000s because the government
in Singapore enforces compulsory savings in the form of the Central Provident Fund (CPF). CPF
may be the reason why the country is running an overall CA surplus because CPF requires
residents to save a high level of savings which resulted in a lower disposable income and will
therefore reduce import spending. Similar to Australia, a CA surplus in Singapore proves that the
country is exporting more than importing. Singapore’s net foreign wealth will also be positive
and will become a net lender to the world. The country can also boost its future consumption
through external means resulting in a balance of trade surplus and FA deficit. The real interest
rate in an open economy is larger and consumers are willing to sacrifice current consumption for
a greater amount of future consumption. Since both Singapore and Australia have different
intertemporal consumption preferences and investment opportunities than the US, both countries
can be made better off as a result of trading consumption claims over time.
Exchange rate Determination

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Macroeconomic Policy Options – Policy changes in the US
In response to the policy changes in the US, there are various policy options that Australia and
Singapore can take through frameworks including the absorption model, the SWAN diagram and
the IS LM BP model. By evaluating and analyzing these policies, we can predict the overall
effect of the change in the US policy on the Australian and Singapore economy.
The Absorption Model – Effects of the Exchange Rate changes
The Absorption model can be used to assess changes in the exchange rate and trade balance as
the model considers the changes to income. Absorption (A) is defined as the total spending by
domestic residents, and can be expressed by A = C + I + G + IM while income (Y) is defined as
the total expenditure of domestic residents, and can be expressed by Y = C + I + G + X. The CA
is the difference between real Y and A therefore, the equation will be ∆(Y-A) = ∆(X-M). Also, as
(X-M) = (Sn-I), it can be concluded that Y-A = X-M = Sn-I.
When the US implemented an expansionary fiscal policy, interest rates in the US will increase.
There will be a decrease in exchange rates and Australia’s and Singapore’s currency will
depreciate. When their currency depreciates, there will be an increase in export demand.
Assuming that both countries are below full employment, the increase in exports will increase
income and output relative to absorption resulting in an improvement in trade balance. However,
the improvement in trade balance will be smaller than the full exogenous increase in net exports
as higher income will lead to an increase in import spending through indirect absorption. This
can be demonstrated through figure, where the starting point is at A. There will be a rightward
shift of the X-IM curve reaching point B.
When the US implemented an expansionary monetary policy, interest rates in the US will
decrease. There will be an increase in exchange rates and Australia’s and Singapore’s currency
will appreciate. The opposite effect will occur compared to the fiscal policy and export demand
will decrease. The decrease in export will decrease income and output relative to absorption
resulting in a worsening in trade balance. This can be demonstrated through figure, where a
leftward shift of the X-IM curve will occur reaching point B where Y a falls to Y b .
The SWAN model
The SWAN model represents the internal and external balance of an economy. Policy makers
would always want both internal and external balance to be in equilibrium to avoid excess
demand or supply in either of the schedules. If disequilibrium occurs, changes to the level of
absorption or the Real Exchange Rate (RER) can be used to restore balance. The RER is the
price of tradeables in terms of domestic non-tradeables. It is a measure of competitiveness and
d f
PT e PT
the formula can be presented as RER = d = d . With an expansionary monetary policy in
PN PN
the US, exchange rates will increase. When exchange rates increase, RER will also increase in
the US as shown in the formula. However, when observed from Australia’s and Singapore’s

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point of view, there will be a decrease in RER. The decrease in RER will cause a decrease in
consumption of non-tradeable goods and increase consumption of tradeable goods because
exports from the US become cheaper. Furthermore, quantity of tradeable goods will decrease and
quantity of non-tradeable goods will increase.
When the following scenario occurs, it will affect Australia’s and Singapore’s internal and
external balance.
Spill over effects of current US policy on Australia and Singapore
Each countries’ choice of exchange rate regime will have different impacts from the external
shock caused by the US expansionary fiscal and monetary policy. First, we will analyze the
spillover effects on Australia. Australia operates under a flexible exchange rate regime. This
means that their currency is determined by the demand and supply on the foreign exchange
market. It is more favorable for the current external shock caused by the US because under a
flexible exchange rate, the nominal exchange rate can change the Real Exchange Rate (RER)
more easily. Assuming that there is perfect capital mobility, there are three key transmission
mechanisms where the policy in the US can spill over to Australia. First is through the income-
expenditure effect resulting from a country’s trade account, second is through monetary impulses
that may be transmitted internationally through their effect on interest rates and the financial
account of the balance of payments, and finally is through relative price adjustments and
movements in exchange rates.
Since the US has implemented 2 policies, both of the effects would need to be considered. Based
on figure 1, the original equilibrium in the US is presented in point A and the original
equilibrium in Australia is point D. With an expansionary fiscal policy, there will be an increase
in domestic output and an increase in interest rate in the US. The IS curve in the US will
therefore shift right reaching point B and output will increase from Y a to Y b . When this scenario
occurs, the initial expansion in output will increase demand for exports from Australia and will
also shift the IS curve in Australia to the right reaching point E. Once that happens, there is an
interest rate differential that is produced because the magnitude in the shift in IS in the US is
larger than the magnitude in Australia. The difference in interest rates will cause the US assets to
become more rewarding and capital inflows in the US will increase. The US has a tendency
towards a BOP surplus while Australia has a BOP deficit. There will be an excess demand for
the US dollar and the exchange rate will decrease. As the exchange rate decreases, the IS curve
will shift left reaching point C. Income will fall again to Y c as Australia will decrease its demand
for US exports. However, it will boost the demand for exports from Australia because Australia’s
exports become relatively cheaper. The IS curve in Australia will shift right even further
reaching point F. It will cause output to expand in Australia showing that a fiscal expansion
transmits short-run growth from the US to Australia and there is no chance of a contraction in
Australia.
Based on figure 2, the original equilibrium in the US is also presented in point A and Australia in
point D. Now instead of an expansionary fiscal policy, we will consider the impact of an
expansionary monetary policy. With an expansionary fiscal policy, the fed in the US will

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decrease interest rates in the country and money supply will increase, causing the LM curve to
shift right reaching point B. This implies that there is an increase in income in the US as Y a
increases to Y b . When income increases, it will also increase the demand for Australia’s exports.
The IS curve in Australia will shift right reaching point E. There is an interest rate differential
where Australia’s interest rates are higher than the US. Australia’s assets are more rewarding
than the US’s assets and there will be excess demand for Australia dollars. Capital outflow will
increase in the US and there will be a tendency towards a BOP deficit while Australia has a
tendency towards a BOP surplus. When this occurs, the US dollar will depreciate as exchange
rate increases. With an increase in exchange rates, exports in the US will become more
competitive and demand for Australian exports will decrease. The IS curve in the US will shift
right causing income to increase from Y b to Y c . Even though an increase in income will increase
the demand for Australia’s exports, the increase in income has a smaller magnitude than the
effect of the increase in exchange rates. Overall, because interest rates have to settle, the IS in
Australia would need to shift left. Although it is impossible to predict without numbers, it is
possible that the income in Australia will decrease. A monetary policy in the US can therefore
cause a contraction in Australia.
After analyzing the impact on Australia, now consider the policy impact on Singapore.
Singapore is different from Australia because the country implements a fixed exchange rate
regime. Under a fixed exchange rate regime, exchange rates cannot change and must be
maintained. With an expansionary fiscal policy in the US (refer to figure 3), the IS curve will
shift right reaching point B where interest rate and income increases. With an increase in income,
demand for exports in Singapore will increase and the IS curve in Singapore will also shift right
but at a smaller magnitude reaching point E. There is now interest rate differentials and exchange
rates will decrease. US dollar will appreciate while Singapore dollars depreciate. There is excess
supply of Singapore dollars and for Singapore to maintain its exchange rates, the country would
need to intervene by buying back its currency. When Singapore buys back its currency, money
supply will decrease and the LM curve will shift left reaching point F. Interest rate will equalize
and the expansion in output is smaller. Singapore will therefore not benefit as much as Australia
in terms of fiscal policy.
With an expansionary monetary policy in the US (refer to figure 4), the LM curve will shift right
as interest rates are lowered and money supply increases. It will reach point B where there is a
BOP deficit and income increases. As income increases, there will be in an increase in
Singapore’s exports and the IS curve in Singapore will shift right reaching point E. In this
scenario, there is an interest rate differential and there is a pressure for exchange rate to increase.
US dollar will depreciate and demand for its exports will increase resulting in a rightward shift in
the IS curve reaching point C. On the other hand, Singapore dollar will appreciate but because
the country implements a fixed exchange rates, Singapore must sell its own currency to maintain
exchange rates. This will cause the LM curve in Singapore to shift right and the final equilibrium
will reach point F where Singapore has benefit from the monetary policy in the US. In terms of
monetary policy, Singapore will benefit more than Australia by maintaining its exchange rates.

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Based on the latest data, current inflation rate of the US is about 1.5%. Due to the coronavirus,
the Fed intends to keep interest rates near 0% as they believed the inflation effects are likely to
be small. However, due to the improvement of economic prospects brought on by the reopening
of the economy, the ramping up of vaccinations, and the Biden administration’s stimulus
package, expected inflation may rise and get out of control. If inflation reaches this point, the
Fed will no longer be able to keep interest rates low and there is a need for it to increase. With an
increase in interest rates, it will put downward pressure on the exchange rate and the US
currency will appreciate. Therefore, both inflation and relative interest rates in the US are
expected to increase even when the Fed is against it.